Where evidence meets policy

Social security: making contributions count

The Chancellor, George Osborne, is keen to strengthen the original contributory principle of the National Insurance scheme, under which the amount people receive in benefits is linked to how much people have paid in; and in doing so, to extend personal responsibility in the welfare system. Steve Hughes of Policy Exchange argues that the current system does not reflect the contributions that people make through their working lives and suggests a radical new approach to restore public trust in the welfare state.

Photo Credit: Helen Cobain

The UK’s social security system is not fit for the 21st Century. It does not reflect the contributions that people make, and its current structure does not reflect the changing nature of the labour market. The Coalition Government have implemented some radical reforms to the system since 2010. However, far more fundamental changes are needed in the next Parliament to ensure the social security system provides people with the support that they need whilst confronting the problems that have developed in the system.

Under a radical new scheme proposed by Policy Exchange, every worker in Britain would have to pay into a new scheme, which combines collective insurance and personalised welfare accounts, putting personal contribution at the heart of the welfare system.

For the first time people who have paid more into the system would receive a greater level of out of work support. Those who work all of their lives could end up with a £10,000 pot when they retire, providing a significant income boost given that the average pension pot is just £36,800.

Contribution and benefits link

Contributory benefits accounted for 41% of the working age welfare bill in the late 1970s, compared to 10% now. Making Contributions Count calls for the next government to legislate for a new welfare system that establishes a clear link between contribution and benefits. The report says that public trust in the benefits system will not be restored until the link between what people have put in and what they get out is improved.

Under the plan, every worker in Britain would contribute a small proportion of their weekly earnings into a new nationwide unemployment insurance scheme entitled My Fund. To make sure workers do not lose out, the government would offset the cost of participating in the scheme through a reduction in National Insurance for employees.

The insurance scheme, run by the private sector but guaranteed by the government, would cover the costs of the first three months of unemployment, replacing the contributory element of Jobseeker’s Allowance (JSA). The new scheme could lead to billions of pounds worth of savings for the government in the long term.

My Fund

At the same time every worker, including the 4.6million self-employed who are currently not eligible for JSA, would be given a personal welfare account, ‘My Fund’, growing by at least £5 a week or £260 a year.

People would be able to build up their fund (and add to it) over the course of their working lives, drawing down on it in times of need such as to retrain for a new profession, something which is becoming increasingly important as the state retirement age rises and people decide to work longer. Upon retirement, any money left in an individual’s account would go towards their pension package.

Individuals would contribute a small proportion of their weekly earnings to the scheme, offset by a reduction in National Insurance payments. This would generate £8billion a year going into My Fund. £2billion of this would go towards an unemployment insurance scheme to partly cover the costs of the first three months of unemployment, replacing the contributory element of JSA.

The remainder (£6billion) would fund a system of individual welfare accounts (‘My Fund’), built around the principle that “it’s your money”. People working over 20hours a week would contribute to a personal welfare account, amounting to at least £5 a week or £260 a year.

Flexible use

People would be able to top up their welfare accounts by up to £100 a week. In times of need, these accumulated savings could be used flexibly, for example, to fund retraining, and, as such, will provide a greater level of support than JSA and Universal Credit.

Universal Credit would act as a safety net for people who run down their pots or have a poor contribution record.

The scheme would not be administered by the government. Instead, to encourage providers to compete for customers based on their service and to ensure funds are sufficiently large to act as effective social insurance, a small number of providers (including insurer and fund managers) should be licensed to offer schemes to every individual.

To limit exposure to uninsurable risks the government would guarantee the scheme as a lender of last resort meaning that, if unemployment rose significantly and unexpectedly, government would cover the extra costs.

There are no easy answers for how to reform social security, but it is crucial that any changes to the system have the aims of reflecting contributory history, being more transparent, and being more cost effective. Only then will public trust be restored to the system, and it can be said that it is fit for the 21st century.